Sep 26, 2017 05:40 PM IST | Source: CNBC-TV18

Vibhav Kapoor sees a correction going ahead due to macros, oil moves; likes pharma space

The only positive for the market is domestic money flowing in. Even this situation could change if interest rates go up, Kapoor told CNBC-TV18.

After consecutive sessions of big declines, the Indian market on Tuesday witnessed a flat opening. The Street could be sitting on the fence ahead of F&O series expiry for September.

In fact, in the past two months, the markets have moved largely sideways, believes Vibhav Kapoor of IL&FS. “I expected a correction. Stocks have been as expensive as ever and there is no case of buying right now,” Kapoor told CNBC-TV18 in an interview.

But, going forward, a correction will take place and there are multiple reasons at play, he said. “Macros are deteriorating and oil price movements need to be watched. As a result, current account deficit could see strain, rupee will fall, among others. Plus, interest rates in the US could go up,” he told the channel. He stressed on the fact that many midcaps had ‘ridiculous valuations’ in pockets such as a few NBFCs, and FMCG, among others.

Explaining the rationale on these valuations, Kapoor explained the case of US markets, where there are stocks with high valuations. They are of cutting edge tech companies such as Tesla and global companies such as Google and Facebook. They are trading at 20-25 times, while some stocks here are trading at 50 times valuations.

In fact, even earnings could face some issues. “We did expect downgrades there. Economy is picking up and there are GST issues, too. Also, analysts are sometimes too positive on earnings and you could end up with not more than 10 percent earnings growth in FY18."

The only positive for the market is domestic money flowing in. Even this situation could change if interest rates go up.

Kapoor is comfortable buying pharmaceuticals in this setup as prices have corrected a lot and a falling rupee will help further. Another sector where one can possibly buy stocks from is private banks. One may not buy it immediately, but they are also available at the top end of valuation. But one cannot go beyond this point.

Among information technology (IT) sector, he remains underweight as it still faces a lot of issues apart from business structure issues.

Meanwhile, in case of power, there has to be a wait-and-watch on Monday’s announcements.

For NBFCs, Kapoor believes in having a positive stance on housing finance companies, while insurance has a lot of growth ahead. But, one has to look at valuation, he added.

Below is the verbatim transcript of the interview.

Anuj: Last time, when we spoke to you, you were a bit nervous about the market. You were saying that things have run up a lot and you do not want to buy right now. What would be a buy zone for you now?

A: That was two months ago almost and in the last two months, markets have really not done much, at least the index. So it has been sideways. I expected a correction so it has taken a sideways sort of form, that correction. But stocks remain as expensive as they were, so there is really no cause to be buying anything even now. And that correction will happen. There are now more reasons for that correction. There are now more reasons for that correction to happen apart from just being a valuation call which it was at that time.

Latha: What is the more reason?

A: Obviously, the macros are probably deteriorating a little bit. Oil is something which we need to watch out for. It is already up to about USD 59-60 per barrel. I think there is a technical breakout, you probably will go to USD 70 per barrel which again, means the current account deficit will be a problem. The rupee will depreciate, interest rates could go up or maybe not, go down. So to that extent, with the valuations where they are and some of the valuations are ridiculous. They are not only high but they are really ridiculous.

So given these circumstances, also the fact that the US interest rates may go up, dollar is strengthening again, the correction will be there. There is no cause to buy anything at this point of time.

Surabhi: So, what are the ridiculous pockets?

A: A lot of midcaps. I do not know, I would not name any stocks.

Latha: Is it specific like non-banking finance companies (NBFC) or something?

A: Yes, there are certain NBFCs, there are certain fast moving consumer goods (FMCG) in the midcap segment. There are maybe auto, lots of companies in the midcap segments. There are lots of companies which are trading at 50, 60, 70 types of price-earnings ratio (P/E) and so obviously they are ridiculous.

Now even if you look at the US market, which is supposedly very expensive, yes there are stocks which are trading at ridiculous valuations there, but those are stocks which are at the cutting edge of technology like a Tesla or something like that. But even stocks which are otherwise global companies and have loads of cash and are growing at 20-25 percent like Google or Facebook are just trading between 20 and 25.

So here you have got stocks which even in a normal sense will not grow more than they have been growing at 15 percent and they are trading at 60 times. I think that is ridiculous. You are not going to make money by buying those stocks.

Latha: Is there a fresh look that you are giving to your earnings calculations of some of the companies probably because GST is turning out to be more difficult than we thought?

A: We did expect that there will be downgrades again, partly because of GST, partly because the economy is still not picking up as much as was expected and partly because analysts are always just too positive on everything and so you start off the year with some 20 percent and then gradually it goes down. So I think this year is no different and you are finally going to end up with not more than 10 percent earnings growth at the most for FY18.

Surabhi: But in that context, just to go back to the point you made about very high valuations, these new numbers, the 30, 40, 50 P/E numbers that we are beginning to see, is this something that the market needs to get used to because of the additional domestic money that is coming in and that is continuing to pour in unabated and unprecedented levels of money?

A: I guess that is the only really positive if you can call it, in the market that there is a lot of domestic money floating, but these are not permanent things. They change. For example, if interest rates start to go up for some reason or when they go up, they will finally go up at some point, the domestic money will reduce. The flows will reduce or something else could happen which could reduce these domestic flows.

So, the point is that even if you are a long-term investor, let us say you have a five year horizon and you are buying a market which is 10 percent more expensive that what the fair price is. You are reducing your returns by 2 percent a year. If you are buying only for two years, you are reducing it by five percent a year. So you are not going to make big money buying stocks at these prices.

Yes, you might still make some money, it is not that you will not probably, you will over a long period of time, but the returns are not going to be great, so maybe it is better to go into a more safer investment where you can get 2 percent less than that but the risk is far less.

Latha: But that is fixed income, it is not giving anything.

A: Whatever.

Anuj: One space where at least the valuations are not ridiculous is IT. But do you have the conviction to buy here because the business model is looking slightly awry?

A: No, because IT is as we have discussed many times, it has got a lot of other problems. Of course, one problem in this whole market has also been the appreciation of the rupee which is not only for IT, but we discussed it last time also that the rupee being so high is not really good for the economy or for the market. That will now correct itself and therefore also, IT should benefit a little bit from that, but IT has a lot of other problems in terms of the whole structure of the business, etc. So, I would still be underweight and a little circumspect on that.

Latha: What did you make of the power announcement that came from the Prime Minister yesterday? Is it stock market relevant?

A: Not immediately. Not immediately. It will take time so all these things are a couple of years, we have to see how it is implemented. So I do not think it has got that much immediate relevance to the stock market.

Latha: So which area are you comfortable buying at all? After all the market is falling even in the midcap space. Where would you start deploying?

A: There are two probably sectors I can think of. One if pharmaceuticals where valuations have come down a lot, stocks have come down a lot, 50 percent, etc. Rupee probably should depreciate a bit from here. And some of their problems seem to be getting sorted out. Valuations are reasonable now, so one could start accumulating those stocks.

While I would not say buy immediately, still private sector banks. I know they are very expensive, there is no doubt about that. But I think that is one sector which has a lot of growth ahead of it still because the public sector banks are not doing well and I do not think they are going to do well for some more time so, market share is going to be taken by the private sector banks continuously. They are going to increase their market share. They are expensive. I am not saying they are not expensive, but they are probably just at the top end of the valuation range. If they go up from here further immediately, I would not buy them.

Latha: When people normally talk about private sector banks as you do, we understand it as HDFC Bank, Kotak Mahindra Bank, IndusInd Bank. What about the other private sector banks we do not normally talk about – DCB Bank, Federal Bank, Karur Vysya Bank? Any of those that also will be something you will watch out for?

A: Some of them could be interesting, but a lot of them are regional banks, so they really need to probably expand their horizon.

Latha: Not in your list?

A: No, they could be, some of them. I would not like to name any. There could also be some new banks, some of these small banks which have just come into being. One needs to look at them. My point is that because the public sector banks are not doing well, the private sector banks are going to do still better for a very long period of time. And while they are expensive, of course, if they were to go up from here another 5-10 percent, you would not probably buy them. But right now, they are just about okay if you are a long-term buyer.

Anuj: I just wanted to come back to the pharmaceuticals point actually. Is this a sectoral opportunity? Do you tell people to straightaway buy the pharma fund because the index itself has fallen 40-45 percent or is this more a stock specific opportunity? You will not name stocks, but we have Divis Laboratories move for example, Aurobindo Pharma move a bit.

A: Actually, pharma by nature, is more of a stock specific sector. It is not a sector where everything is the same because there are different types of drugs, there are different types of businesses, different geographies, etc. So, pharmaceuticals I always treat as a stock specific sector where you look at specific stocks rather than a sector as a whole.

Surabhi: Similar question on a different space, NBFCs. Now because the tide was up, all boats got lifted, but there is insurance, there is housing finance, there are asset reconstruction plays, there are the broking companies, what is it that you are comfortable holding or buying?

A: The housing finance companies still are okay. Maybe insurance again has a lot of growth ahead of it. But you have to look at the valuations. So if an NBFC is trading at 10 times, 15 times, 20 times book value, whatever sector it may be, I do not think it is worth it. You are not going to make that money out of it.

Surabhi: You do not think there is some sort of froth in housing? There has been that increasing debate on the street whether there is a bubble in housing finance.

A: I do not think there is a bubble, but competition is increasing. So you have a lot of banks are there and a lot of new housing finance companies, lot of NBFCs coming into housing finance. So, therefore certain amount of care is required to select the companies and as I said, the valuations. That is very important.
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